On June 25, 2014, in Fifth Third Bancorp v. Dudenhoeffer, the US Supreme Court held that employee stock ownership plan (ESOP) fiduciaries are not subject to the so-called Moench presumption of prudence and are bound by the same duty of prudence that applies to all ERISA fiduciaries (with the exception of the duty to diversify) (No. 12-751, (June 25, 2014)). Routinely applied by circuit courts, the presumption acted to protect ESOP fiduciaries from liability due to declining stock prices.

Though the Court unanimously rejected the Moench presumption, its opinion in Dudenhoeffer also provides helpful guidance to ESOP fiduciaries defending claims from participants alleging fiduciary breaches based on declining stock prices.

Fifth Third Bancorp (Fifth Third) maintained a participant-directed defined contribution retirement plan for its employees and matched up to 4% of a participant's compensation to the plan. Assets of the plan were invested in 20 funds, which included mutual funds and an employer stock fund, which the Supreme Court referred to as an ESOP. Participants were able to allocate their contributions among the 20 funds as they chose, however the 4% match was first invested in the ESOP, after which participants could move the funds.

(Technically, there is a distinction between this type of plan, typically referred to as an eligible individual account plan (EIAP), and a traditional ESOP, which invests primarily or solely in employer stock. However, the Court did not address this distinction and its holding arguably applies to fiduciaries of EIAPs and traditional ESOPs. For more information on the distinction prior cases made between EIAPs and ESOPs, see Article, Presumptively Prudent? It depends: Applying the Moench Presumption to EIAPs).

Between July 2007 and September 2009, Fifth Third's stock price dropped by 74%, causing participants to lose a large portion of their retirement accounts. Participants claimed that by July 2007, Fifth Third, as the plan fiduciary, knew or should have known that the stock price was overvalued because:

After the decrease in share price, Participants claimed that Fifth Third violated ERISA's fiduciary duty of prudence by continuing to offer Fifth Third stock as a plan investment.

The district court dismissed the Participants' complaint for failure to state a claim, applying the Moench presumption of prudence at the pleading stage, as several other Circuit Courts have done in recent years (see, for example, Legal Update, Second Circuit Adopts Moench Presumption for Plans Mandating Investment in Employer Stock).

Participants appealed to the Sixth Circuit, which decided that the presumption was evidentiary and could not be applied at the pleading stage. The Sixth Circuit held that although Fifth Third was entitled to a presumption of prudence, the plaintiffs had overcome the presumption.

Fifth Third petitioned for certiorari, and the Supreme Court granted the petition.

The Court held that:

The prudent person standard requires the diversification of investments to minimize the chance of loss. However, because ESOPs are designed to invest primarily in the employer's stock, they are by definition not diversified. Congress reconciled this inconsistency exempting fiduciaries of ESOPs and EIAPs from the duty to diversify under ERISA Section 404(a)(1)(c) and the duty of prudence (to the exent it requires diversification) under ERISA Section 404(a)(2) (29 U.S.C. 1104(a)).

The Court read ERISA Section 404(a)(2) literally and found that it provided only a narrow exception from the prudent person requirement "to the extent that it requires diversification." The Court clarified that ERISA Section 404(a)(2) does not require plaintiffs to allege that the employer is on the "brink of collapse" or "dire circumstances," standards that emerged from prior cases adopting the Moench presumption.

In reaching its decision, the Court rejected Fifth Third's arguments, explaining that:

In vacating and remanding the case to the Sixth Circuit, the Court provided helpful guidance to ESOP fiduciaries, especially with regard to defeating participant lawsuits at the motion to dismiss stage, stating that:

The Court noted that ERISA's duty of prudence does not require the fiduciary to break insider trading laws and, therefore, it cannot require an ESOP fiduciary to divest the plan's holdings on the basis of inside information. It also instructed lower courts to consider the extent to which an ERISA-based obligation to refrain from trading or disclose inside information to the public would violate securities laws or their objectives, and encouraged the SEC to provide its views on these matters.

ESOP fiduciaries will be subject to the same fiduciary duty of prudence as other ERISA fiduciaries (with the exception of the duty to diversify) and can no longer rely on the Moench presumption of prudence. Fiduciaries of both ESOPs and EIAPs with employer stock should be made aware of this decision and consider ways to address a decline in the value of employer stock both for the benefit of their plan participants and in accordance with securities laws.

However, employers should closely follow the Sixth Circuit case on remand as well as future cases interpreting Dudenhoeffer because the guidance the Court provided to lower courts (see Helpful Guidance for ESOP Fiduciaries) may well provide a high bar to a plaintiff's future success alleging ERISA fiduciary breaches based on declining employer stock prices.